When 'Eight' Isn't Enough

What's Your 'Magic' Retirement-Savings Number?

By

Karen Blumenthal

October 5, 2012

You are working hard to save for a decent retirement. So wouldn't it be nice to have a simple rule of thumb to measure whether you are saving enough?

Last month, Fidelity Investments, the nation's largest provider of 401(k) plans, tried to do just that, offering up "eight" as the magic number: Typical wage earners, it said, should aim to save at least eight times their final annual pay to be sure they can afford basic living expenses in retirement.

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The financial-services company also offered benchmarks to measure your progress along the way. By age 35, your goal is to save an amount equal to your annual pay. By 45, you will want to have saved about three times your salary, rising to five times your salary by 55.

There is a catch, of course: Most of us aren't typical. And for above-average earners, those numbers might seem daunting—and be way too low.

To come up with the formula, Fidelity had to make numerous assumptions. Its "typical" worker began saving 6% of his earnings at age 25, gradually increased that to 12% after six years and continued saving that amount each year until retiring at 67. (An additional employer match helped, too.)

He earned about $40,000 in today's dollars initially and retired with annual pay just under $74,000.

In addition, the savings grew 5.5% a year every year—or 3.2% after inflation—something that is impossible in the volatile real world, where investments soar one year and shrink another.

Last, the model assumes the saver will start retirement by withdrawing about 5% of savings, a higher drawdown rate than the 4% usually recommended.

In reality, says Beth McHugh, Fidelity's vice president of market insight, the multiple you need to save "will vary."

While perhaps overly simplistic, Fidelity's attempt to quantify a magic number is a worthy exercise because it gets people thinking about savings and especially encourages young people to start saving early, says Steve Utkus of the Vanguard Center for Retirement Research, an arm of financial-services giant Vanguard Group. The center takes a different approach, urging savers to put away 12% to 15% of their income every year, including employer matches, to reach their retirement goals.

So how much should you save? Here's a guide to finding a magic number for your own situation:

• The more you make, the more you need to save, not just in dollars but as a multiple of your final salary. The reason: Social Security payments will provide a smaller percentage of your desired income than it will for Fidelity's typical worker, so you will have to provide more.

Christopher Jones, chief investment officer of Financial Engines, which provides services to 401(k) participants, says someone making $150,000 a year at retirement might need 12 times his salary to maintain his standard of living.

The Center for Retirement Research at Boston College took a crack at the problem in 2010. It estimated that people making $150,000 to $200,000 needed to save three times their salary at age 45 and 10.3 times their final pay at age 65.

Underscoring how much assumptions matter, the Boston College center used a higher real rate of return on investments than Fidelity's—4.5% versus 3.2%. The center found that retirees needed between four and 10 times their final pay, depending on whether their incomes were below or above average.

• If you plan to retire early, you will need to save more—and you might not have a choice in the matter. In another argument for saving while you are young and sticking with it, a survey earlier this year by the Employee Benefit Research Institute, an industry-funded nonprofit, found that half of retirees left work unexpectedly because of health reasons or layoffs.

• Your lifestyle matters. The Fidelity model assumes you need to replace 85% of your final pay--since you will save on payroll taxes, you won't need to add to your 401(k) and work-related expenses decline. But if you have been saving a lot and your house is paid off, you might be able to live on even less, which will reduce your savings burden.

In addition, if you have been sending children to college and graduate school in your later years, you might find that retirement without those expenses is surprisingly cheap.

• Other savings will help. If you have a pension plan, even a small one, it will reduce what you need to save. On the other hand, if you are a conservative investor who is unwilling to take some risk in the stock market, you will need a bigger magic number to compensate for a lower real return.

Retirement experts suggest that once you are in your 50s, you should consult a financial planner or experiment with online calculators to figure out the number you need to support the retirement you want. You will have to do a lot of guesswork, estimating your final pay, inflation and investment returns. (You can estimate your Social Security income here.)

There are too many variables to accurately project the exact number. The best you can hope for is a high probability that you won't outlive your money.

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